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CURRENCY AND TRADE WARS JUST AROUND THE CORNER

As I begin writing about half-way through today’s trading session, I see the broad stock averages are all trading lower, Treasury bond prices are trading lower and the U.S. dollar is also trading lower against all major currencies. I refer to days like this as “triple-down-days” and ask myself, “Where did the money go?” The obvious answer is NOT into U.S. assets. The other simple answer says that traders are lightening-up on positions, especially in the dollar and bonds in front of the September Labor Report due out at 8:30 Eastern tomorrow morning. Stocks have been struggling throughout the day due to yet another record high for crude oil and weak sales reports coming from Wal-Mart, J.C. Penney, Starbucks, and Corning. Bonds have been selling-off in anticipation of improved labor conditions and optimism for economic growth, but stocks just can’t seem to break through the significant overhead resistance. It’s nearly impossible to comment on today’s financial markets without going into politics in some fashion. With the presidential elections just over three weeks away and our “jobless recovery” in question, the labor report should prove to be highly sensitive both politically and in the financial markets.

The labor report should have its biggest effect on the bond market since interest rates are very sensitive to expectations of economic growth and contraction. I made careful note to see that the bond futures prices for 5-year, 10-year and 30-year Treasuries closed the last two days just below the 50-day moving average. A good report tomorrow could easily send bond prices plummeting to test their respective 200-day moving averages in very short order. If the bullish spinsters get it right tomorrow with a good report we will see the money moving out of Treasuries find its way to the stock market. This would be a glorious time to see a two or three week rally in stocks if the goal is to get the incumbent president re-elected. Higher interest rates plus a renewed stock rally would also give the dollar a boost as we get closer to the polls.

Most market participants are anticipating a decent report tomorrow, but it looks like the market is being conditioned to expect a good number. Yesterday Federal Reserve Bank of Kansas City President Thomas Hoenig said the job market “has begun to improve” and the Bloomberg article goes on to say, “Payrolls rose the most in four months in September, the government will probably say tomorrow. Faster job growth may add to the case for interest-rate increases, lifting demand for dollars from investors seeking higher yields.” It looks like the propaganda is in place to send stocks and the dollar higher and bonds lower in these final weeks leading up to the elections…let’s see if the stock bulls can pull it off to give the current administration a quick boost.

Economy and Stocks

In my mind the biggest negative influences on stock prices today came from the mixed retail sales numbers. Here are two more Bloomberg quotes that briefly summarize the retail sentiment. “‘There clearly are some pretty dismal numbers and some pretty nice numbers too –it’s mixed,’ said Michael Niemira, the shopping-center group’s chief economist. ‘The broad story though is one of a sluggish pace that kicked-in back in June. We really haven’t kicked out of that.’” Another analyst interviewed said, “The consumer is not in great shape. Confidence is weak and getting worse.” I’m also surprised to hear very little in the press about the weak report we got on Tuesday from the ISM. The ISM non-manufacturing index in September fell to 56.7 versus 58.2 in August. Expectations called for an increase to 59.0. Lately we have been hearing of improvements in the manufacturing sector, but that is only about 15% of the total U.S. economy. The recent report depicting weakness in the service sector accounts for nearly 85% of our economy! Waning consumer confidence with weak retail sales and a weakening service sector don’t bode well for stocks after the elections. Between now and election-day just about anything could happen.

Keep in mind the most important thing is to keep a solid perspective on the big picture. Yesterday Martin Goldberg wrote, “Throw away the cookbook and focus on the big picture…We’re seeing levels of speculation that are actually like those of late ’99 early ’00.” He went on to detail the broadening topping pattern that we have seen on a number of charts in 2004. Then says, “The five-point broadening patterns were prevalent in the 1929 stock market top, and since then have occurred only rarely until this year.” Combine Martin’s observation with Richard Russell’s continuing comments on the non-confirmation of the Dow Industrials and the Dow Transports. He continues to marvel at the divergence or non-confirmation lasting for the last eight months and quotes other Dow theorists in the significance of the non-confirmation…it means trouble ahead! Now combine those two schools of technical thought along with the evidence of a weakening economy, and for the life of me I can’t understand why investors believe in the Wall Street spin of buy and hold for the long-term. I say preserve what you have and get out of the way of trouble.

I’ve been waiting to see if we were going to get another miracle rally in the last hour, but not today. The Dow Industrials ended-up skidding out on the lows for the day by losing 114 points to close at 10,125, the NASDAQ Composite dropped 22 points to 1,948 and the S&P 500 ended the day 11 points lower to close at 1,130. Yesterday the DJIA closed above both its 50-day moving average and 200-dma. Today the DJIA closed below both moving averages. Momentum indicators for the NASDAQ Composite are in overbought territory and rolling over. In my eyes, the risk of being invested in the broad stock market far exceeds the potential reward based on both market fundamentals and technical analysis.

A Note of Caution

Those of you that have been reading my market comments know that I am pound-the-table bullish on the precious metals sector. I am still wildly bullish, but I happened to notice some late-day trading that is noteworthy if you are invested in gold and silver mining stocks or trading futures contracts. Nothing significant happened in the metals themselves today with spot gold closing at $417.50 (down 20 cents) and spot silver closing at $7.18 (down three cents), but in the last hour the HUI Gold Index succumbed to some heavy selling. It traded almost all day between 234 and 235, but in the last hour fell to close near the low at 231.5. This same exact pattern has happened prior to previous sell-offs in gold and silver the following day.

Looking at it from a different angle, the Commitment of Traders report has shown that the Specs have been piling in on the long side, so it could be ripe for the Commercials to force the Specs into a sell-off by taking out all the stops on the way down. This could happen tomorrow with a strong labor report since it would most likely rally the dollar while the short sellers get heavy handed in the gold and silver pits. If this does happen tomorrow, I don’t expect it to last long. I view any near-term decline in gold and silver as a buying opportunity. Oil is hitting all-time highs, copper is breaking out to a new high, the CRB Commodity Index is breaking out of its recent consolidation to the upside, and there is clearly a great deal of stress with currencies in the foreign exchange markets.

Silence From the G-7 Meeting

Since we have heard very little from the countries that attended the G-7 meeting last weekend, I’ve been looking for clues to see what may have come out of the last pow-wow. Going into the meeting I pointed out that the Euro has endured most of the damage caused by the declining dollar. The strengthening euro has hurt European exports since they have not gone out of their way like Japan to weaken their currency versus the dollar. Based on the current situation I figured France, Germany, and Italy would have some strong words to alleviate their declining competitiveness with international trade.

Late in the day I caught this Bloomberg story about speculation the yen should strengthen. This is a classic in propaganda or call it “spin” if that’s easier to swallow. It looks to me like the reasoning is pretty thin at best.

Yen Strengthens on Optimism Japanese Economic Expansion Will Be Sustained

Oct. 7 (Bloomberg) -- The yen rose against the dollar for the first day in five on speculation a report tomorrow will show Japan's machinery orders rebounded in August after the biggest drop in almost three years.

Signs Japan's economy will extend a five-quarter expansion may help the yen trim its 3.5 percent decline against the dollar this year. Japan's index of leading economic indicators rose to the highest since March, the government said today.

Japan's currency is “significantly undervalued” against the dollar, General Motors Corp. Chief Executive G. Richard Wagoner Jr. said in an interview from Irving, Texas. He reiterated his view that Japan's government shouldn't sell its currency to weaken it. Detroit-based GM, the world's largest automaker, benefits from yen gains, which make Japanese cars less competitive in the U.S.

It looks to me like Italy, France and Germany were leaning on the U.S. and Japan to give them a break on currency intervention by allowing the yen to appreciate as it naturally should. Obviously without the $300 billion Japan spent to weaken the yen, it would have appreciated along with the euro and Japan would have paid part of the price for the dollar decline of the last three years. If in fact Japan allows the yen to move higher, they will have growing problems with China because Japan’s export prices will need to rise relative to China. The proof would be in the pudding tomorrow if we see the dollar and yen move higher while the euro moves lower to get some “trade” relief.

In the last paragraph of the Bloomberg snippet, notice the comments made by the CEO of General Motors. Remember that auto sales in the U.S. are hitting a serious slowdown, even with zero interest financing and lucrative purchase incentives. Japanese auto makers are taking market share away from GM, so the CEO must fight back any way he can. If the Finance Ministry in Japan doesn’t allow the yen to appreciate, the next step for CEO’s of auto makers here in the U.S. is to lobby for import tariffs on foreign made cars. Think of this along with the recent formal complaint by the U.S. about Airbus receiving government subsidies making them more competitive versus U.S. plane makers like Boeing. Right now it looks like 2005 is shaping up to be the year of global currency trauma and travails, and the beginning of protectionist tariffs and global trade wars. If my prognostications come to fruition, I doubt we will know it until after the upcoming elections have passed.

Today was a good example of how stocks, bonds and the dollar can all go down on the same day. In fact, I believe the correct LONG-TERM positions are short stocks with a slowing economy, short bonds because interest rates are still artificially low, and short the dollar because of the long-term fundamental problems with our federal budget deficit and trade deficits. They won’t all go down together like they did today, but by the end of next year I expect all three to be lower. You will need to be thinking “out of the box” with a special focus on currencies and commodities to make money over the coming year. (If you would like to discuss your portfolio, shoot me an email and we can exchange ideas.) Once the elections are out of the way it’s probably time to buckle your seatbelts and don your helmets for the coming volatility in stocks, bonds, and currencies.  Interesting times we live in!!

Have a Great Evening!

Mike Hartman

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